nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2009‒12‒11
eight papers chosen by
Alexander Harin
Modern University for the Humanities

  1. No-arbitrage, overlapping sets of priors and the existence of efficient allocations and equilibria in the presence of risk and ambiguity By Rose-Anne Dana; Cuong Le Van
  2. Framing effects of risk communication in health-related decision making. Learning from a discrete choice experiment By Florence Nguyen; Marie-Odile Carrère; Nora Moumjid
  3. Some Considerations Regarding the Problem of Multidimensional Utility By Martin Binder
  4. Underweighting Rare Events in Experience Based Decisions: Beyond Sample Error By Greg Barron; Giovanni Ursino
  5. A Reexamination of the House Money Effect: Rational Behavior or Irrational Exuberance? By Sugato Chakravarty; Yongjin Ma
  6. Pleasure and belief in Hume's decision process By Marc-Arthur Diaye; André Lapidus
  7. Is cross-category brand loyalty determined by risk aversion? By Nadja Silberhorn; Lutz Hildebrandt
  8. Contraction Consistent Stochastic Choice Correspondence By Dasgupta, Indraneel

  1. By: Rose-Anne Dana (CEREMADE - CEntre de REcherches en MAthématiques de la DEcision - CNRS : UMR7534 - Université Paris Dauphine - Paris IX); Cuong Le Van (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Panthéon-Sorbonne - Paris I, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris)
    Abstract: The theory of existence of equilibrium with short-selling is reconsidered under risk and ambiguity modelled by risk averse variational preferences. A sufficient condition for existence of efficient allocations is that the relative interiors of the risk adjusted sets of expectations overlap. This condition is necessary if agents are not risk neutral at extreme levels of wealths either positive or negative. It is equivalent to the condition that there does not exist mutually compatible trades, with non negative expected value with respect to any risk adjusted prior, strictly positive for some agent and some prior. It is shown that the more uncertainty averse and the more risk averse, the more likely are efficient allocations and equilibria to exist.
    Keywords: Uncertainty, risk, common prior, equilibria with short-selling, variational preferences.
    Date: 2009–11
  2. By: Florence Nguyen (GATE - Groupe d'analyse et de théorie économique - CNRS : UMR5824 - Université Lumière - Lyon II - Ecole Normale Supérieure Lettres et Sciences Humaines, Centre Léon Bérard - CRLCC Léon Bérard); Marie-Odile Carrère (GATE - Groupe d'analyse et de théorie économique - CNRS : UMR5824 - Université Lumière - Lyon II - Ecole Normale Supérieure Lettres et Sciences Humaines, Centre Léon Bérard - CRLCC Léon Bérard); Nora Moumjid (GATE - Groupe d'analyse et de théorie économique - CNRS : UMR5824 - Université Lumière - Lyon II - Ecole Normale Supérieure Lettres et Sciences Humaines, Centre Léon Bérard - CRLCC Léon Bérard)
    Abstract: Background How to communicate uncertainty is a major concern in medicine and in health economics. We aimed at studying the framing effects of risk communication on stated preferences in a discrete choice experiment (DCE) performed to elicit women's preferences for Hormone Replacement Therapy. Methods Two versions of the questionnaire were randomly administered to respondents. Multiple risks were expressed as natural frequencies using either a constant reference class (Design 1) or variable reference classes (Design 2). We first tested whether Design 1 would impose a lower cognitive burden than Design 2. We then examined whether the two designs resulted in different utility model estimates. Results Design 1 improved consistency (monotonicity and stability). However, rates of dominance or intransitive responses did not differ across designs. Design 1 decreased women's sensitivity to the risk of fractures and increased their sensitivity to the risk of breast cancer as compared to all other attributes. Discussion Framing effects of risk communication on stated preferences may be a major problem in the design of DCEs. More research is needed to determine whether our findings are replicable and to further investigate the normative question of how to improve risk communication in health-related decision-making.
    Keywords: Framing effects; Risk communication; Discrete choice experiment
    Date: 2009
  3. By: Martin Binder (Max Planck Institute of Economics, Evolutionary Economics Group, Jena)
    Abstract: The concept of 'utility' is often used in ambiguous ways in economics, from having substantive psychological connotations to being a formal placeholder representing a person's preferences. In the accounts of the early utilitarians, it was a multidimensional measure that has been condensed during the marginalist revolution into the unidimensional measure we know today. But can we compare different pleasures? This paper assesses the evidence from psychology and neurosciences on how to best conceive of utility. It turns out that empirical evidence does not favor a view of multidimensional utility. This does not eliminate the possibility to make a normative argument supporting a multidimensional notion of utility.
    Keywords: utility, pleasures, neuroeconomics, multidimensionality of utility
    JEL: D87 B41 B12
    Date: 2009–12–08
  4. By: Greg Barron (Harvard Business School); Giovanni Ursino (DISCE, Università Cattolica)
    Abstract: Recent research has focused on the "description-experience gap": While rare events are overweighted in description based decisions, people tend to behave as if they underweight rare events in decisions based on experience. Barron and Erev (2003) and Hertwig, Barron, Weber, and Erev (2004) argue that such findings are substantive and call for a theory of decision making under risk other than Prospect Theory for decisions form experience. Fox and Hadar (2006) suggest that the discrepancy is due to sampling error: people are likely to sample rare events less often than objective probability implies, especially if their samples are small. The current paper examines the necessity of sample error in the underweighting of rare events. The first experiment shows that the gap persists even when people sample the entire population of outcomes and make a decision under risk rather than under uncertainty. A reanalysis of Barron and Erev (2003) further reveals that the gap persists even when subjects observe the expected frequency of rare events. The second experiment shows that the gap exists in a repeated decision making paradigm that controls for sample biases and the "hot stove" effect. Moreover, while underweighting persists in actual choices, overweighting is observed in judged probabilities. The results of the two experiments strengthen the suggestion that descriptive theories of choice that assume overweighting of small probabilities are not useful in describing decisions from experience. This is true even when there is no sample error, for both decisions under risk and for repeated choices.
    Keywords: experience-based decisions, Prospect Theory, rare event, overweighting, underweighting
    JEL: D81 C91
    Date: 2009–10
  5. By: Sugato Chakravarty (Purdue University); Yongjin Ma (Purdue University)
    Abstract: We reexamine the presence of the house money effect (HME) within the context of a dynamic financial experiment. Our specific innovation lies in introducing the Becker-DeGroot-Marschak (1964) bidding mechanism within our experimental design in order to ameliorate, or altogether eliminate, the peer pressure effect. In doing so, we find weak evidence, at best, of the HME. In fact, our results overwhelmingly support rational behavior by our experimental subjects. Our findings stand in contrast to extant research, and one study in particular, that has reported the existence of the HME using Vickrey auctions within a dynamic financial context. Our findings survive robustness tests and imply that subjects are mostly rational in their risk attitudes.
    Keywords: House money effect; expected utility theory; experimental economics; Becker-DeGroot-Marschak procedure; Vickrey auction
    Date: 2009–05
  6. By: Marc-Arthur Diaye (Centre d'Etude de l'Emploi - Université d'Evry-Val d'Essonne); André Lapidus (PHARE - Pôle d'Histoire de l'Analyse et des Représentations Economiques - CNRS : FRE2541 - Université Panthéon-Sorbonne - Paris I - Université de Paris X - Nanterre)
    Abstract: The purpose of this paper is to introduce explicitly pleasure and belief in what aims at being a Humean theory of decision, like the one developed in Diaye and Lapidus (2005a). Although we support the idea that Hume was in some way – evidently different from Bentham's or Jevons' way – a hedonist, we lay emphasis less on continuity than on the specific kind of hedonism encountered in Hume's writings (chiefly the Treatise, the second Enquiry, the Dissertation, or some of his Essays). Such hedonism clearly contrasts to its standard modern inheritance, expressed by the relation between preferences and utility. The reason for such a difference with the usual approach lies in the mental process that Hume puts to the fore in order to explain the way pleasure determines desires and volition. Whereas pleasure is primarily, in Hume's words, an impression of sensation, it takes place in the birth of passions as reflecting an idea of pleasure, whose “force and vivacity” is precisely a “belief”, transferred to the direct passions of desire or volition which come immediately before action. As a result, from a Humean point of view, “belief” deals as well with decision under risk or uncertainty, as with intertemporal decision and indiscrimination problems. The latter are explored within a formal framework, and it is shown that the relation of pleasure is transformed by belief into a relation of desire, which belongs to a non-empty class of relations, among which at least one is a preorder.
    Keywords: Hume, decision, pleasure, belief, passion, desire, preference, rationality, discrimination, will, choice
    Date: 2009–06
  7. By: Nadja Silberhorn; Lutz Hildebrandt
    Abstract: The need to understand and leverage consumer-brand bonds has become critical in a marketplace characterized by increasing unpredictability, diminishing product differentiation, and heightened competitive pressure. This is especially true for fast moving consumer goods (FMCG) manufacturers and retailers. Knowing why a customer stays loyal to a brand in multiple product categories is necessary for deriving suitable marketing strategies in the context of a brand extension, yet research on the motives, characteristics, life styles and attitudes of cross-category brand loyal customers has been investigated only in a limited number of studies. We will fill a gap in the literature on cross-category brand choice behavior by analyzing revealed preference data with respect to brand loyalty in several categories in which a brand competes. Provided with purchase and corresponding survey data we investigate the product portfolio of a leading nonfood FMCG brand. We segment consumers on the basis of their revealed brand preferences and, focusing on consumers’ risk aversion, identify cross-category brand loyal customers’ personality traits as determinants of their brand loyal purchase behavior.
    Keywords: cross-category brand loyalty, risk aversion, share of category requirements, customer segmentation
    JEL: M31 C51
    Date: 2009–12
  8. By: Dasgupta, Indraneel (University of Durham)
    Abstract: We model a general choice environment via probabilistic choice correspondences, with (possibly) incomplete domain and infinite universal set of alternatives. We offer a consistency restriction regarding choice when the feasible set contracts. This condition, 'contraction consistency', subsumes earlier notions such as Chernoff's Condition, Sen's α and β, and regularity. We identify a restriction on the domain of the stochastic choice correspondence, under which contraction consistency is equivalent to the weak axiom of revealed preference in its most general form. When the universal set of alternatives is finite, this restriction is also necessary for such equivalence. Analogous domain restrictions are also identified for the special case where choice is deterministic but possibly multi-valued. Results due to Sen (Rev Econ Stud 38: 307-317, 1971) and Dasgupta and Pattanaik (Econ Theory 31: 35-50, 2007) fall out as corollaries. Thus, conditions are established, under which our notion of consistency, articulated only in reference to contractions of the feasible set, suffices as the axiomatic foundation for a general revealed preference theory of choice behaviour.
    Keywords: stochastic choice correspondence, contraction consistency, regularity, Chernoff’s condition, weak axiom of revealed preference, weak axiom of stochastic revealed preference, complete domain, incomplete domain
    JEL: D11 D71
    Date: 2009–11

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